Published on August 18th, 2014

This morning I addressed the University of the Third Age Redlands at the Donald Simpson Centre, Cleveland on the topic of The Australian Economy: Where we’ve come from, where we’re going. My prepared remarks are reproduced below. I varied the address in the delivery, but the main points are the same. Slides are available via SlideShare.

The Australian Economy: Where we’ve come from, where we’re going

Good morning. You may have seen it reported last week that Australia’s unemployment rate has increased to 6.4%, the highest rate we’ve seen in twelve years, and there is some concern over the short-term economic outlook. There’s certainly a risk that Australia’s dream economic run, of unbroken economic growth for more than two decades, may come to an end if housing construction doesn’t replace the economic boost provided by mining investment in recent years. But it’s too soon to tell how long the weakness in the labour market will continue, or whether it’s a sign of worse to come.

Over the last decade or so, Australians have typically been used to good economic news, or at least better economic news than in other countries. Since the financial crisis of 2008, the Australian economy has been a standout performer among the advanced industrialised economies that make up the OECD. Of course, this was not because our economy has been performing exceptionally, but because we avoided a recession unlike the US, UK and Europe.

Partly this may have been luck, partly good management. There have been arguments about the effectiveness of the short-term fiscal policy response – Keynesian pump-priming through the stimulus packages, incorporating the Rudd money, Pink batts, school halls, et cetera – but there is a lot of agreement that the Australian economy has been made much more resilient through reforms to our economy that have occurred, particularly since the 1980s.

As well as making our economy more resilient, these reforms have led to a material increase in our living standards, particularly relative to our OECD peers.

After starting in the top third of the OECD when it was set up in the 1960s, we had dropped down to the bottom third by the 1980s, before regaining a top third position in the 2000s. In my view, and that of the Commonwealth Treasury and Productivity Commission, economic reforms since the 1980s have been important to achieving this.

Today I’m going to touch on the reforms that I think were most important. It’s important to consider these reforms because their benefits will endure and will not be erased by any short-term downturn the economy may come to experience if our luck finally runs out.

But before discussing the important economic reforms we’ve seen in Australia, I’ll give a sketch of Australia’s economic history since 1788. This will allow us to understand how profound the changes we’ve seen have been.

As we catch up to the present, I’ll then turn to where the economy is going. I’ll refrain from commenting on the short-term outlook, which is typically highly uncertain, and instead focus on the longer-term. This will allow me to discuss some profound trends, including:

Collaborative consumption or the sharing economy,

Rapid technological change, including massive improvements in artificial intelligence, automation, and robotics, and

Growing inequality of income and wealth.

Sketch of Australia’s economic history

We are all broadly familiar with Australia’s history since 1788, and Australia’s history of convicts, soldiers and settlers coming to a land sparsely inhabited by its Indigenous population. Our first economic success was in agriculture, and in the 1820s and 1830s there was a pastoral boom based on merino sheep.

While Australia developed at a reasonable pace in the early nineteenth century, it was gold that transformed Australia, with the gold rushes in Victoria in the 1850s encouraging mass migration to Australia, from Europe but also from China and elsewhere. In the 1850s, Australia’s population nearly trebled from 400,000 to 1.1 million.

Much of the prosperity of the late nineteenth century was based on gold, and its benefits are reflected in the lasting grandeur of the city centres of Melbourne, Ballarat and Bendigo, among others. Closer to home, the discovery of gold in Gympie in 1867 saved the Queensland economy from depression and the Government from bankruptcy.

So mining has always played an important role in Australia’s economic history, although, its importance has waxed and waned over time, fluctuating in a range from 2-10% since Federation, and for a good part of our history Australia has ridden on the sheep’s back, particularly in the 1950s when we benefited from the wool boom associated with the Korean War. Economic historians have shown that agricultural industries contributed 20-25% of Australia’s GDP for the first half of the twentieth century, but this share had dropped to 5% by 1980 and is even lower now.

As agriculture declined in importance, other sectors rose to prominence, particularly manufacturing, which increased from around 12% of the economy at the time of Federation to 25-30% of the economy in the fifties and sixties. However, its share dropped to around 20% in the early 1980s and has progressively declined even further.

Australia’s manufacturing sector, to a large extent, particularly for the automotive and textile, clothing and footwear industries, was supported by tariffs. For example, at one time, the tariff on passenger motor vehicles was set at 57%.

Australians have always had a mixed attitude to free trade, accepting its importance in some circumstances – for example, the desire to have free trade among the Colonies motivated federation in 1901 – but protection from foreign manufactured goods has often been seen as desirable. The infant industries argument for tariff protection was very fashionable for a time – we just needed to protect our infant manufacturing industries long enough so that they could become economically viable.

As an island nation with a small manufacturing base, Australia has always been heavily dependent of overseas trade and overseas investment – indeed, Australia has traditionally imported capital from overseas, borrowing money or receiving investment dollars from other countries, traditionally the UK, but also the US and Japan, and now China is playing a huge role. Broadly speaking, Australia gets the foreign exchange we need to import the goods and machinery we need by exporting minerals and agricultural goods (now much less important than the minerals) and also from foreign investment and borrowings from overseas.

Having lived through the 1980s and Paul Keating’s period as Treasurer, you will be well aware of Australia’s persistent current account deficit, which is a reflection of our position as a small country with lots of investment opportunities that is reliant on foreign capital.

We can’t consider Australia’s economic history without acknowledging that Australia has suffered from some significant financial panics and economic depressions, particularly the great depressions of the 1890s and 1930s, each of which was associated with very high unemployment and each of which in its own way transformed Australia. The 1890s depression helped foster the growth of the Labor Party and the trade union movement, and arguably contributed to the very rigid, centralised industrial relations system we eventually found incompatible with the dynamic prosperous economy we want to be.

The Great Depression of the 1930s, of course, profoundly altered the attitudes of the population and contributed to the creation of the welfare state after the Second World War, where the Commonwealth Government, in particular, assumed greater responsibilities for social security. This was aided by the Commonwealth having assumed income taxation powers during the war, and the High Court decision in the Second Uniform Tax Case in the 1950s, in which the Court decided it was too late to turn back the clock and return income taxation powers to the States. This along with a number of other High Court decisions, including the Tasmanian Dams case, has entrenched Commonwealth dominance in federal-state relations, which desperately requires reform, as I’ll discuss later this morning.

Apart from our strong population growth and changing population composition, one of the most remarkable changes in the Australian economy in the last 100 years has been the massive expansion of Government in terms of its spending, regulation of the economy, and intervention into the social and family realms on a previously unimagined scale. This occurred with largely bi-partisan support in the post-war period, with significant expansion of education, health and social security under conservative governments in the post-war period. Of course, as is well known, the Whitlam Government of 1972-75 was responsible for a big leap in Commonwealth involvement and spending, particularly through offering free university education.

In his fantastic overview of Australia’s political history in the 1980s and 1990s, The End of Certainty, former editor of the Australian newspaper Paul Kelly described the critical elements of Australia’s economy for much of the twentieth century, which he defined as the Australian settlement. Those elements included:

Heavy industry protection based on tariffs – indeed after the war we tried to create a car industry through encouraging foreign direct investment in Australia as the only way car companies could sell into Australia as we had very high tariffs, tariffs which reached 57% at their peak as I noted earlier;

A centralised industrial relations system based on arbitration;

State paternalism – a philosophy that underpinned Australia’s welfare state and also the Government effectively acting as an employer of last resort in the post-war period, often through State-owned businesses such as railways, right up to the 1970s, when the policy was no longer economically viable; and

Imperial benevolence, most important economically as the preferential tariff treatment of Australian goods exported to Britain, which ended when Britain joined the common market in 1973.

The need to reform the Australian settlement was probably already clear when Britain joined the common market, particularly as Australia’s relative economic performance was deteriorating and the age of stagflation, with simultaneously high unemployment and inflation was beginning. We were slipping down the OECD table in living standards, as we were being overtaken by recovering European countries and Japan, and we had restricted the dynamism and productivity of our economy through heavy regulation and government ownership.

The 1970s saw the end of the long boom we had enjoyed since the end of the war. The long boom was propelled by strong population growth due to the baby boom – with the fertility rate reaching over 3 children per woman in the early 1960s – and strong immigration particularly from war-ravaged Europe. Australia’s population grew from 7½ million at the end of the war to 14 million in 1975 and now 23 million in 2014.

The end of the long boom forced Governments starting with Whitlam’s to consider hard policy choices. Whitlam, despite his faults on economic policy, actually did make a number of sensible policy choices. For example, the 25% tariff cut in 1974 and the breaking up of the old Postmaster General’s Department and the creation of Australia Post and Telecom, which ultimately led to greater efficiency in postal and telecommunications services.

But there was much more reform to be done. Whitlam was too beset with political and pressing macro-economic problems to do much in the way of micro-economic reform, and unfortunately the Fraser Government largely wasted its opportunities for reform, with Fraser apparently acting as a block to his reform-minded Treasurer John Howard (although Fraser denies this). Regardless, economic reform was on hold under the Fraser Government. It was with the election of the Hawke-Keating Government in 1983 that Australia’s major economic reforms began – reforms, which in the interests of being non-partisan and balanced, were largely supported by the Liberal Party.

Australia’s transformation since the 1980s

Australians were probably unprepared for the economic policies of the Hawke-Keating Government, not suspecting that a Government that won office largely on the basis of a public health care scheme, Medicare, would engage in such significant market liberalisation, approaching though not as radical as what happened under Thatcher in the UK and David Lange and Roger Douglas in New Zealand.

Economic reform in the 1980s really began with the floating of the Australian dollar in December 1983. Previously the Reserve Bank of Australia maintained a fixed exchange rate but there was huge pressure for the dollar to devalue as the rate was too high and foreign investors were pulling their money out of Australia.

There was a lot of debate about whether floating the dollar was a good idea, and it’s been reported the then Treasury Secretary John Stone was concerned that a floating dollar would be a speculator’s plaything, and that Australian industry would suffer due to large swings in the dollar that would result from speculation. But eventually pressures from financial markets were too strong to resist floating the dollar, and the Government decided to float in December 1983.

Floating the dollar probably emboldened the Government for further reform and indeed helped show the need for further reform as the currency fell and concerns over Australia’s economic future and living standards intensified. Pretty soon, as Paul Keating famously noted, every pet shop galah was talking about microeconomic reform – meaning the reform of markets, regulations affecting businesses, and government-owned businesses.

Major reforms undertaken by the Commonwealth Government included financial market deregulation –the relaxation of many restrictions on financial markets in the mid-1980s, which led to the establishment of many new providers and the entry of foreign banks into Australia, and the privatisation of the Commonwealth Bank in the 1990s.

The Commonwealth also sold Qantas and State Governments privatised or corporatised a number of their businesses, particularly utilities and railways. The pressure for further market-oriented reforms eventually led to the high watermark of microeconomic reform in Australia – the Hilmer Report and the adoption of National Competition Policy in the early 1990s. This committed governments across Australia to removing unwarranted restrictions on businesses and to competitive neutrality with business – i.e. so government businesses don’t gain unfair advantages such as not paying tax when competing with private businesses.

These reforms led to the abolition of a lot of uncompetitive practices, many of which were promoted by State Governments, particularly marketing boards, such as the Queensland Sugar Board. Marketing boards, while supporting prices for primary producers, by controlling the supply of products in an economy, were costly to consumers, who paid the price of support to producers. Some uncompetitive practices died hard, however. Government-imposed restrictions on sugar marketing lasted until 2006 in Queensland.

Microeconomic reform was also seen in the reform of many government-owned businesses, many of which were eventually corporatised, such as Queensland Rail and our power businesses Energex and Ergon which you may recall were once electricity boards such as SEQEB and NORQEB. Corporatisation led to much cost-cutting as government-owned businesses strove to cut costs and improve productivity.

Finally, the Hawke-Keating Government committed to cutting tariffs and industry protection, which was particularly high in the automotive industry and the textile, clothing and footwear sector. The Government’s commitment to reducing industry protection, a move that would significantly reshape our economy in the 1990s, especially so as tariff reductions at the start coincided with a major recession that led to a large loss of manufacturing jobs. You may recall commentary in the early 1990s about Victoria being a rust belt, and certainly weak economic conditions in Victoria led to strong interstate migration to Queensland.

The combination of economic reforms in Australia in the 1980s and 1990s translated into historically high productivity growth in the 1990s. Productivity can be thought of as a measure of how much we can produce with one labour hour, and this measure grew strong in the 1990s.

This was possible due in part to people being worked more intensively, a point repeatedly made by John Quiggin, but there’s no doubt the increase in productivity markedly improved Australia’s economic performance, particularly relative to the traditional productivity leader, the US.

Although many major reforms had already been undertaken by the Hawke-Keating Government, as John Howard took office in 1996, there was still urgent need for reform in two key areas: the tax system and industrial relations.

Howard and his Treasurer Peter Costello did well to convince Australians that we needed to reform our tax system to introduce an efficient Goods and Services Tax (GST) and to replace a range of less efficient taxes, such as sales tax. Unfortunately the States didn’t abolish all the inefficient taxes they should have and we still have stamp duty in Queensland, which creates a significant restraint on property transactions, reducing the mobility of people to where jobs are, and leading to higher insurance bills. Also, in bringing in the GST, a deal with the Democrats led to exempting fresh food and many health and education items, reducing somewhat the efficiency of the GST.

Regarding workplace relations, while the Keating Government undertook significant reforms in the early 1990s, bringing in Enterprise Bargaining, much remained to be done. Truly flexible workplace agreements between businesses and employees couldn’t be reached because of the no-disadvantage test, which meant agreements couldn’t leave workers worse off than previously. But in some workplaces, particularly some public sector agencies or government-owned businesses, workers had very favourable agreements that probably needed some reform. Also, unfair dismissal laws were a major disincentive for employers to hire staff, because they’d worry that if they hired a bad staff member it might be very difficult to get rid of them.

WorkChoices was hence a much-needed reform, in my view, but was very unpopular with the electorate and arguably cost John Howard the Prime Ministership. With the election of the Rudd Government, WorkChoices was substantially unwound. But with unemployment increasing and business concerns about the cost of employing people in Australia, no doubt industrial relations will re-emerge as a major policy issue sometime in next decade.

Where are we going from here?

So that brings us up to the present day, and it’s time to consider where is the Australian economy going from here?

There’s significant concern over the immediate outlook with mining investment dropping and unemployment rising. Many commentators are worried about what happens after the mining boom, and they’re asking where will the jobs come from?

But there will always be jobs for people to do, especially in the services sector, which now accounts for over 75% of the economy. Recent forecasts from Deloitte Access Economics suggest strong jobs growth over the next few years in services, particularly in health, education and aged care, the latter a result of the ageing of the population, as the large baby boomer cohort moves into retirement age.

Incidentally, this has implications for consumption patterns and the types of goods and services in demand. There will be a great emphasis on cost-effective lifestyle and wellness goods and services by baby boomers. People who can help baby boomers age gracefully and keep fit and healthy will do well. I expect personal trainers, yoga instructors and other service providers will respond to the demands of retiring baby boomers with time on their hands, many of whom would have significant disposable incomes. Tourism providers will also benefit, and not just from grey nomads, but they will need to provide superior and interesting tourism experiences for baby boomers, many of whom have already traveled to many interesting places around the world.

In the medium to longer-term some important global trends will be important in shaping our economy.

First I’ll discuss collaborative consumption or the sharing economy – “what’s mine is yours” as Rachel Botsman, the expert on collaborative consumption, describes it. We’re realising that it no longer makes sense to own as many things as we once did, as the internet makes it so easy to find people who own something we want to borrow or hire, such as a motor mower or car.

Think about the ride sharing service Uber, for example, which now threatens the traditional business model of the taxi industry, which is protected by government regulation. Similarly Air BnB is providing an emerging threat to hotels and serviced apartments, by making it easy for home owners to temporarily rent out their houses or rooms.

The internet also makes it easy to find people who might want to barter or offer services in the expectation they’ll eventually be rewarded – an economy that operates on karma. An example of this is couch surfing websites that let people find places to crash in foreign cities.

Another important global trend is that technology is improving at an incredible rate in a wide range of areas. Longevity may increase significantly owing to medical advances, meaning that the growing senior section of population will have an even greater transformative impact on our economy. There are also potentially large implications from wearable technologies, such as Google glasses or wearable computers that constantly monitor our health and alert us or medical authorities to possible heart attacks or strokes.

Automation and robotics are also profoundly important. Major car companies such as Volvo have invested billions of dollars in developing driver-less cars, which will lead to great efficiencies on the roads and in car parks, as cars drive closer together, have fewer accidents, and find car parks for themselves, so you can spend more time doing what you want to do rather than parking a car.

Regarding robots, if you see the quality of robots being developed in Japan, it’s not unreasonable to expect in a few decades perhaps robots will undertake a wide variety of jobs as well as our housework. Some people worry about whether this will cause mass unemployment, but I’m not so worried about that.

Robots will massively increase the productivity of our economy and will mean that, in theory, we can all work fewer hours to enjoy the same standard of living as robots will be doing a lot of the work. Of course, much will depend on who owns the robots and its possible robots could create further inequality if the rich own the robots and a large segment of the population don’t have robots and can’t find employment. This is a possibility, but because society would be richer we could afford to spend more on welfare and I expect wealthier robot owners would have to support the losers in the robot age. Hence it’s possible we could see further expansion of the welfare state. As with the internet and globalisation, improving technology such as robotics would add to inequality – a global trend recently highlighted in French economist Piketty’s best-selling book Capital in the 21st Century.

So as long as Australian Governments remain committed to a progressive tax system and income redistribution, it’s possible Australia could remain reasonably egalitarian and meritocratic despite these trends, although of course there has been a significant bulge in the incomes and wealth of the people at the top end, the so-called 1%, in recent years.

Finally I think market reforms and the trend toward deregulation will continue. People are demanding greater choice in their lives and greater responsiveness from businesses and service providers. People expect a 24/7 economy, and regulations that are incompatible with this, such as Queensland’s archaic retail trading hours restrictions, are bound to be reformed sooner rather than later.

Conclusion

To conclude, Australia has transformed itself over the last few decades, both as an economy and as a society. We have less government intervention in business, but in some social and family areas there is a growing reach of government, particularly in childcare. Our future looks bright but requires careful management and an ongoing commitment to reform, particularly in the areas of taxation and industrial relations, which will remain controversial economic issues over the next decade at least.